All crowdfunding capitalists should ask this question

Commentary: Equity-funding platform’s company-vetting process is key

RyanCaldbeck

Shutterstock.com

One of the most common questions I hear about equity crowdfunding as the CEO of CircleUp, a leading equity crowdfunding platform, is this: Will investors actually make money?

There’s no question that private investing in early stage businesses is a high-risk, highly illiquid endeavor. That doesn’t mean that investors can’t earn attractive risk-adjusted returns. To do so, however, they will need to use high-quality crowdfunding platforms to decide which companies to invest in. While there are many ways to judge crowdfunding platforms, there is one that stands out: How thoroughly does the platform vet the companies that apply to the site?

Browning: What's the end game in bond rally?

(3:35)

Analysts have been warning for years that the bottom could fall out of the surging bond market. But they have been wrong, E.S. Browning says on MoneyBeat. (Photo: AP)

At CircleUp, we only accept a low-single-digit percentage of companies that apply to our platform. This alone, however, doesn’t guarantee that only high-quality companies make it through to investors. What are some other factors that might lead to greater accuracy in the vetting of businesses? Focus? Expertise? Experience?

Our own focus is on one industry: consumer products/retail. We chose this area because the return profile of angel investments in the consumer sector is very strong and because that is where our investing experience lies. According to the Kauffman Foundation, angel investments in consumer and retail have generated average returns of 3.6x invested capital in just over four years (while the Kauffman Foundation’s data set is limited, it is the best data available).

It was my experience as a private equity investor at TSG Consumer Partners and Encore Consumer Capital — firms that focus exclusively on investing in high-growth consumer companies — that led me to found CircleUp. At these firms, I evaluated thousands of investment opportunities and observed highly distinct patterns both in companies that were successful and those that were not.

Due diligence

While our vetting process eliminates all companies not in consumer and is highly informed by our consumer investing experience, the next level down focuses on the specific company.

Ryan Caldbeck.

We look for companies with a strong performance history and compare the company’s internal metrics to important industry benchmarks. For example, we use SPINS data to verify consumer take-away of a company’s products at retail (this tells us if companies are just loading retailers with inventory or if consumers are really buying the product), and we now have a dataset of more than 2,000 companies that have applied to CircleUp to compare applicants across many different benchmarks.

Besides financial performance, we conduct a thorough assessment of a prospective company’s management team: What is the team’s track record? What other investors has the team attracted? Has the CEO made hiring decisions to complement his or her skill set? We also conduct background checks on entrepreneurs prior to listing on CircleUp.

Besides company-specific metrics, we scrutinize the exit prospects of CircleUp applicants. Large consumer-products firms increasingly don’t want to expend the time or capital to innovate; it’s much easier to buy a proven brand than to spend millions of dollars and several years trying to launch a product whose time might have passed once it gets to market.. For example, if we see a coconut water product, it’s unlikely to make it on to CircleUp because retail beverage giants Coca-Cola and PepsiCo have already made their coconut water plays. We look for companies selling products that are both differentiated from competitors and complementary to the relevant strategic buyers.

Finally, be mindful of valuation. The number one reason CircleUp will not accept an otherwise-qualified company on our website is because the entrepreneur seeks a valuation that is out of line with comparable transactions. Our team of experienced consumer investors and our extensive dataset on market comparables may help keep valuations on CircleUp in line with the market overall. Entry valuation goes a long way toward determining an investor’s return, so it’s critical that investors are not paying 10x revenue if a strategic buyer will only pay 3x down the road.

It’s been just over a year since CircleUp launched, and we have now supported 21 capital raises to the tune of more than $21 million. The average company that has raised money on CircleUp has seen their revenue grow at 80% per year after they raised money on CircleUp, and their gross margins have expanded from 34% pre-CircleUp to 39% post-CircleUp.

It’s one thing to say our vetting process produces the best companies, but the fact is that only the platforms that focus deeply on their vetting process will put investors in the best position to succeed in an inherently risky asset class.

Ryan Caldbeck is founder and CEO of CircleUp, an equity-based crowdfunding platform

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.